Fundamentals of Insurance Chapter 1 PDF

# Fundamentals of Insurance ## Chapter 1: Introduction to General Insurance ### A Brief Perspective Insurance is about "risk sharing." People historically have shown a willingness to pool resources to help others in need. Insurance is a formalization of the basic principle of risk sharing. * **E...

# Fundamentals of Insurance ## Chapter 1: Introduction to General Insurance ### A Brief Perspective Insurance is about "risk sharing." People historically have shown a willingness to pool resources to help others in need. Insurance is a formalization of the basic principle of risk sharing. * **Early history:** Chinese boat operators as early as 5000 BC redistributed their cargoes to multiple boats as they approached treacherous rapids on rivers. If one boat was lost, all boat owners shared the loss. * **Growth of marine insurance:** As overseas shipments increased, merchants found it impractical to deal with exposures informally, leading to the birth of the marine insurance industry. * **Fire insurance:** The birth of fire insurance is traced to London, England. * In September 1666, an oven fire destroyed much of the city. * The next year, a London dentist began offering insurance against the risk of fire to select dwellings in London. * Within a few years, full-time insurance underwriters replaced merchants, and the industry grew. * Today, there are approximately 109 general insurance companies in Canada (other than life and health), with 10 of these providing over 67% of insurance purchased by Canadians. ### Five Functions of Insurance 1. **Spread of risk:** Insurance can be viewed as a large pot into which all insureds place shared premiums. In addition to paying the cost of running the business, this pot has the ability to contribute to the fund - to share the losses of the few. The ability for payment of a loss - to share those losses of the few among the many - is the major function of insurance. 2. **Basis of Credit System:** Consumer access to insurance frees up credit. Bert and Betty Butler live in Yourtown. Like most Canadians, they have had to use loans to finance the purchase of their car, cottage, home, and business. The availability of insurance strengthens credit markets and lenders help to facilitate the granting of investments. 3. **Eliminates Worry - Encourages Entrepreneurship:** The availability of insurance allows people to engage in many ventures because they have set money aside to meet the financial requirements that the insurance company may pay, should an undefined expenditure (the insurance premium) to cover large but uncertain future losses, much of the anxiety and worry about the unknown future is reduced. 4. **Loss Prevention and Loss Reduction:** In addition to paying for losses, the insurance industry works hard to prevent losses and to reduce their severity. Active partnerships have been formed with communities and public officials to deal with important issues such as road safety, fire prevention, and anti-theft measures. Other such partnerships have included a nation-wide campaign to fight insurance fraud. 5. **Source of Employment and Investment Capital:** Canadian insurers employ more than 100,000 people, including independent brokers, adjusters, and actuaries. Claims total into the billions of dollars annually. Assets controlled by insurers amounted to more than $114 billion in 2015. ### Definition of Insurance "The undertaking by one person to indemnify another person against loss or liability for loss in respect of a certain risk or peril to which the object of insurance may be exposed... or to pay a sum of money or other thing of value upon the happening of a certain event." An analysis of the definition of insurance reveals five important points: 1. **Insurance provides a means of shifting one’s financial responsibility for a loss to another party.** * Bert and Betty Butler own Butlers' Best Buy Furniture Ltd. * Insurance provides them with a means of shifting these financial obligations to others. * In exchange for money, the insurance company assumes financial responsibility for the Butlers' losses. They are referred to as "insureds." 2. **Payment will be made only in the event of the happening of a certain risk or peril.** * Risk is defined as the chance of financial loss, and insurance can be purchased to cover many exposures. * Peril is simply defined as the cause of loss, such as fire, wind, or hail. 3. **The amount of the payment is restricted to the amount required to indemnify the insured.** * The purpose of insurance is to indemnify or compensate the victim of a loss. * The principle of indemnity ensures that people receive the actual amount of their loss, no more and no less. * To pay more would enable people to profit. * To pay them less would result in an incomplete indemnity. * The insurer will attempt to determine the value of the insured property as it existed immediately prior to the loss. 4. **Insurance covers losses to which the object of insurance may be exposed.** * The purpose of insurance is to pay for those losses which are both accidental and future. * It is not intended to respond to losses which are deliberate or which have already occurred. 5. **The indemnity provided can be in the form of a sum of money or other thing of value.** * The insurance company always has the right to settle a claim either by repairing or replacing the damaged item(s) or by paying the insured money for the damaged item(s). ### Property and Casualty Insurance in Canada Property and casualty (P&C) or general insurance involves all types of insurance other than life and health insurance. It includes: * **Automobile Insurance:** Automobile insurance premiums represent more than 50% of all property and casualty premiums in Canada. * **Property insurance:** Habitational and business properties represent the second largest source of premiums to insurers. * **Liability insurance:** Liability insurance provides protection when insureds are financially responsible for injury or damage they cause to others. Premiums from liability insurance represent the third major source of income to insurers. ### Organization of Insurance Insurance in Canada is distributed by two distinct types of organizations: * **Private insurers:** The majority of insurance business in Canada is transacted by private insurers. * **Stock companies:** Most insurance written in Canada today is provided by stock companies. Ownership rests in the hands of the company’s shareholders whose main purpose is to derive a profit from their investment. * **Mutual companies:** A mutual company is a corporation owned by its policyholders. The creation of profit is not a primary incentive. Instead, the main goal is to provide policyholders with insurance at as low a cost as possible. When the company makes money, it is refunded to the policyholders directly through dividends or through subsequent rate adjustments. * **Government insurers:** Federal and provincial governments are involved in providing various insurance plans, including medical insurance, employment insurance, and workers’ compensation. In British Columbia, Saskatchewan, Manitoba, and Quebec, governments provide compulsory automobile insurance coverages to residents and may, in most of these provinces, compete directly with private insurers for additional or excess coverages. The government also competes with private insurers for property and other classes of insurance. ### How Insurance is Distributed Insurers use different methods to sell their products, including: 1. **Direct writing System:** Producers are employees of the insurer and are limited to selling only those products provided by the insurer. Remuneration may be on either of a salary or commission basis or a combination of salary and bonus. The insurer owns all of the business written and performs all administrative functions. 2. **Independent Brokerage System:** There are over 6,500 independent agency/brokerage insurance offices in Canada employing over 33,000 people. It is estimated that over 80 percent of all property and casualty insurance is sold through this system. These offices are also used to distribute compulsory government automobile insurance in British Columbia, Saskatchewan and Manitoba. 3. **Agency System:** While brokerage and agency are often used interchangeably, agents are distinct from brokers and direct writers. Agents represent one insurer and the Facility Association, but agents are small business owners. ### Lloyd's of London Conventional Property and Liability insurers are able to write insurance for a wide variety of exposures. However, Lloyd's of London has proven to be a valuable insurance Market option. Lloyd's of London was established in the late 17th century to write marine insurance. It is not an insurance company, and it does not transact any insurance business itself. Rather, the Lloyd's Corporation consists of a group of companies and individuals called underwriters who assume risks for themselves. Underwriting membership is open to anyone meeting the financial requirements of the Committee of Lloyd's. ### Syndicates As marine insurance became more complex, more underwriters were required to subscribe to the risks. This led to the formation of syndicates which are composed of underwriting members or names. An underwriting agent manages the affairs of each syndicate and appoints an expert underwriter for each class of business written. ## Chapter 2: Types of Insurers There are two major types of insurers: 1. **Private Insurers:** Private insurers transact the majority of insurance business in Canada through Stock Companies and Mutual Companies. * **Stock Companies:** The ownership of the company is in the hands of the company’s shareholders with a main purpose of deriving profit. * **Mutual Companies:** Mutual companies are owned by its policyholders where the creation of profit is not the primary incentive. 2. **Government Insurers:** Government insurers are involved in providing various insurance plans, such as medical insurance, employment insurance and compulsory automobile insurance coverages. ### Methods of Distribution Two main methods are used by insurers to sell their products: * **Direct Writing System:** * Remuneration: Salary or Commission basis or combination of Salary and Bonus * Ownership of client files: Insurer owns files * Administration functions: Insurer handles administration * **Independent Brokerage System:** * Remuneration: Commission on business written * Ownership of client files: Brokerage owns files * Administration functions: Brokerage handles administration * **Agency System:** * Remuneration: Commission and Bonuses * Ownership of client files: Agents own files * Administration functions: Agents handle administration The most common distribution method is the Independent Brokerage System.